October 23 – Stock futures came under pressure again overnight, as Middle East tensions continue to escalate. The VIX traded to a seven-month high above 23 overnight, remaining near 22 at this hour, reflecting the heightened fears regarding the Middle East war. The dollar index continued to consolidate near 106.2, even as Treasury yields continue their trend higher. Yields on 10-year Treasuries hit a fresh 16-year high above 5.02% earlier this morning, although they are currently trading near 4.97%, while yields on 2-year Treasuries are trading near 5.12%. Crude oil prices are 1% lower on fears that the Middle East war will prove to be a drag on the global economy, while the grain and oilseed markets were mixed to lower in early trade to start the week.
The world still waits for the anticipated Israeli ground offensive in the Gaza Strip, but Israel has apparently been convinced to delay that invasion thus far. Tanks and troops are positioned for the surge into Gaza, but they remain at the border this morning. That eased concerns of the crude oil market overnight, but it didn’t ease concerns that a prolonged war could negatively impact the economy, weighing on stocks and raising risks for crude oil demand. The crude oil market is particularly vulnerable, as a broadening conflict could raise greater supply risks than the current demand risks raised by the conflict. Thus the volatility and price swings in the ebb and flow of emotions in the crude oil market. For today at this hour, the money flow is to the negative side, but the market remains quite vulnerable to headline risk.
Rising interest rates play into the above as well, weighing on the longer-term economic outlook as the market wakes up to the likely reality that we’re going to see rate “higher for longer” going forward, even if the Federal Reserve isn’t behind it. I’m finally hearing other economists start to tout the same risks tied to the large volume of debt certificates hitting the market amid soft demand as the Fed continues to shrink it’s balance sheet. As such, the Fed has acknowledged that the higher rates on the long end of the yield curve are doing much of its work for it, but at some point, that Federal Reserve will need to be concerned about that work doing too much damage to the economy. We’re not there yet, but that would be the next phase of this monetary cycle. The market has been focused on when the Fed will pivot its interest rate policy, but the bigger question may revolve around when it finds that it must pivot its balance sheet tightening to keep interest rates from going too high. We still have surplus money in the system, but I do believe that the continual supply of debt certificates being offered onto the market due to Congressional spending will eventually require the Fed to review its policy, and perhaps restart its quantitative easing program where it creates money to buy debt certificates again. That increases the supply of money in the system, which typically would be expected to depreciate the value of the dollar and to be inflationary.
The strong dollar has been one of the factors creating headwinds for the commodity sector. A strong dollar makes it difficult for U.S. commodities to compete on the global market. The dollar has generally risen as Treasury yields have risen, but that relationship isn’t as strong as it once was. In general, the currency trade tends to chase the currency tied to the central bank that is perceived to have the most hawkish policy, and that’s generally been the dollar and the Federal Reserve of late. The European Central Bank has tried to signal that it is close to pivoting policy. But will it be able to do so? Inflation is even more sticky in Europe than it is here in the United States, and a lot of that has to do with wage inflation – something we’ve also talked a lot about here in the States. But labor laws are stronger in Europe, making it more difficult to layoff workers, and many wages are tied directly to inflation. That means that wage inflation tends to self-perpetuate itself to some extent. As such, we can’t just assume that the ECB will be able to pivot policy, nor that the dollar will continue its trek higher.
Good rains fell across two-thirds of Argentina’s parched crop belt over the weekend, although the forecast dries out again over the next 10 days. Nonetheless, that will help with early corn planting. Thunderstorm activity is expected to increase over Center-West Brazil this week, although the storms are expected to be scattered in nature with less coverage and intensity than expected last week. The next 10 days should help set the stage for the Brazilian soybean crop, regarding how these rains perform in the days ahead. Do they again disappoint, or do they provide the necessary relief? That will likely have a big impact on farmer selling in Brazil, and therefore on Brazil’s price structure, impacting Chinese buying decisions. That in turn should help determine whether the U.S. balance sheet tightens going forward, or whether softer exports allow prices to fall.
